Now What? Post COVID-19 and the Oil Market Crash, what will the M&A Market for the Small, Private Businesses Look Like?
As an operator of a private business, you’ve been scrambling to manage your organization in the now current COVID-19 world. Directing staffing, inventory levels and liquidity – all with an eye toward what the recovery will look like post COVID-19. And, for several of you, you’ve also been managing a parallel path toward a future divestiture – right up until the Coronavirus hit. So, the obvious question is, now what?
Let’s look at some market fundamentals, weigh in some analyst projections and make some conclusions.
Financially, the environment for the lower tier M&A market was and continues to be firmly sound. It is estimated that over $2 trillion remains available in private equity funds plus a quarter of billion dollars in private debt funds. Likewise, the health of the general economy was solid prior to the outbreak and the banking system was well capitalized – unlike the Great Recession of 2008-2009. This is coupled with the fact we will clearly be in a low interest rate environment for some time to come. With that said, estimates for unemployment could be as much as 5% at the start of Q2 and we could see a 50% drop in GDP over the same timeframe.
So how long are we talking? Again, estimates range from a long range recession to rapid recovery. For reference purposes, Morgan Stanley expects the impact to be short-lived with GDP rebounding to 3.1% growth in the second half of 2020. A myriad of different projections are available, but plan on three to six months for the system to recalibrate as companies rebuild and then stabilize.
Closer to home in the Southwest US, the energy producing states have taken two direct hits in COVID-19 and an extremely oversupplied oil market that has dropped prices for crude oil over fifty percent. As it relates to energy, while outside of the scope of this note, most industry analysts project a stepped-up recovery. For example, Moody’s Investor Services targets WTI reaching the $40 to $45/bbl. range by the end of 2020 with a forecast of $50 to $55/bbl. for 2021. Other services, such as, Fitch, project a $38/bbl. recovery for 2020 and a more modest $45/bbl. target range for 2021. While not the robust levels most in the oil-patch were hoping for, it is nonetheless a strong recovery from the current twenty dollar mark.
The U.S. government has responded appropriately to stem the tide from both a health and financial perspective in passing the $2 trillion Cares Act – which is double the previous stimulus provided during the 2009 financial crisis. The Act includes the $350 billion paycheck protection program, as administered through the Small Business Administration, and is a program all small, private organizations should investigate thoroughly. To date, equity markets have responded positively to the government’s action, but these steps are only intended to bridge a brisk recovery. As it relates to private market activity, there is obviously a delayed reaction as no clear share price discovery is available; but most private equity firms will be quickly summarizing the valuation of their holdings for the period ending Q1. It is far from a stretch to say that most all holdings and future market entrants will see a softer valuation than what would have been observed at the start of the year.
Where does that leave the owner of a private, lower middle-tier business who has been planning his exit for six months?
As previously noted, there remains a significant amount of equity capital available for investment, and we continue to receive numerous pronouncements that “we are open for business and ready to invest”. And we believe this is true, but realistically on a measured path due to the simple fact that many people, systems and infrastructure are operating in a COVID-19 environment. The fact remains that solid businesses that produce free cash flow on a reliable basis will remain highly attractive. Each business will be measured on its own basis and those that are centered around discretionary activities such as travel and leisure or those focused entirely on energy commodity prices will be looked at through a different lens, but strong, growing companies with a competitive edge will still prove to have ample value. Although, due to the soft first half of the year, sellers should be prepared for deal structures that use future based performance earnouts to provide added value, if Q1 and Q2 declines prove to have been short-lived dips. Lastly, the market will remain very competitive for new private offerings, but they may face new competition because public investments and distressed situations will possibly look more attractive than previously. So, it is important to button-up your business now and move your offering to the front of the queue!